From the Heights of $100 Oil, Most Stocks Look Vulnerable

THE recent spike in oil prices is probably a passing mania, many investment strategists say. But they warn that if oil remains near record levels next year, it would hurt most domestic stocks, with the notable exception of energy companies.

“The market clearly is not pricing in $100 oil and the economic restraint on growth that would be implied in that,” said Stuart A. Schweitzer, the global markets strategist at JPMorgan Private Bank, a unit of JPMorgan Chase. In the New York futures market, the price of a barrel of oil settled Friday at $88.71, down from $98.18 the previous week.

If oil prices were to hover around $100 next year, Mr. Schweitzer said, that would have negative implications for the stock market. Investors would probably be advised to rotate from cyclical stocks to more defensive industries that tend to fare well in a weak economy.

An example of cyclical stocks that could be among the most vulnerable would be those of companies that make products whose purchases can be postponed, like new automobiles and vacations. A better bet might be health care and consumer staples, like food and beverages, which generally hold up well when times are tough.

Mr. Schweitzer also said higher gasoline prices might spell even more trouble for the hard-pressed home builders. “Most new development today takes place in outlying suburbs,” he said, “so that could be yet another drag on the home-building stocks.”

Some energy experts say American consumers have not even begun to feel the pain at the pump from the rapid rise in crude oil prices.

“Higher gas prices are right around the corner,” said Dan Pickering, an analyst at Tudor, Pickering & Company, an energy stock research firm in Houston. He estimated that gas prices could climb to $3.50 a gallon early next year.

Higher pump prices and home heating bills could put a big strain on American consumer spending, which accounts for about 70 percent of gross domestic product, said David Wyss, the chief economist of Standard & Poor’s.

Mr. Wyss said most retailers would probably lose business. “Consumers tend to trade down” if their wallets are pinched by higher energy prices, he said. Although Wal-Mart might pick up some shoppers who would ordinarily have gone to Macy’s, he said, that probably would not be enough to offset losses in Wal-Mart’s core customer base.

One exception might be some of the luxury stores, Mr. Wyss said, especially those in big cities that can attract foreign tourists eager to exploit the weak dollar. Tiffany might do just fine, even with higher energy costs, he said. “High-end customers are not going to be as hurt by gasoline prices.” But, he added, “they are more likely to stay away if they’re nervous about what’s happening in the stock markets.”

In much of the country, Mr. Wyss said, high gasoline prices next summer would probably hurt the big hotel and restaurant chains. “That would have less impact on McDonald’s, because they are everywhere,” he said, but many family-oriented restaurant chains could lose business if families took fewer road trips.

Photo

On the deck of a deep-water drill ship in the Gulf of Mexico. Some investment strategists say they think current high oil prices are temporary.Credit
Stephen Hilger/Bloomberg News

Automakers might suffer if gasoline prices remained above $3 a gallon, “especially the American manufacturers, because they don’t make enough relatively fuel-efficient cars and trucks,” he said.

Mr. Wyss recently raised his forecast for the average oil price in 2008 from $75 to $85, a level that, he said, would not be as bad for the economy as an average price of $100. Of course it would be even better for consumers if oil fell back to $70 a barrel, roughly its average price this year, he said, “but it would not be a windfall. You just wouldn’t have the negative effects.”

Many experts attribute the recent price spike to a combination of speculation and over-reaction and say crude oil prices could deflate just as rapidly.

Michelle Dathorne, a credit analyst at Standard & Poor’s who specializes in energy companies, said current supply and demand did not support oil at $100 a barrel. Over the last two years, there has been a fairly constant premium of $20 to $25 a barrel built into oil prices because of geopolitical concerns, she said. Until recently, rising prices were responding to demand. But she attributed the recent spike almost entirely to market speculation.

Michael Metz, the chief investment strategist at Oppenheimer & Company, was even more dismissive of traders who, he said, have bid up oil prices. “I think this is a minibubble reflecting hysterical buying by speculators, who are fearful that we will embark on some sort of adventure in Iran and destabilize oil sources in the region,” Mr. Metz said.

He predicted that a major correction in oil prices was imminent. But he said he did not expect this to hurt energy stocks, because $100 oil was not factored into their share prices.

He also said that if crude oil prices fell back too rapidly, the major oil producers would probably cut production. “One quarter of the world’s output is controlled by Saudi Arabia and Russia. If oil fell to $70 a barrel, they would cut,” he said.

WHILE major integrated energy companies like Exxon Mobil and Chevron have prospered in the current environment, Mr. Metz said he preferred the stocks of independent production companies right now.

“They are both an earnings play and an asset play,” he said, because the independents could be takeover targets for the major energy companies.

Mr. Pickering, the energy stock analyst, also liked the independent producers, like Devon Energy and Anadarko Petroleum. He also favors the deep-water drillers, including Transocean and Halliburton, because that is where most of the new oil finds are these days, he said.

But Mr. Pickering said that even energy stocks — the one area of the market that could benefit from higher commodity prices — would be better off if crude oil prices fell back closer to their average for this year, because $100 oil could reduce global demand.